Fannie And Freddie: Mission Accomplished!

Affordable housing has allegedly been at the heart of the mission of Fannie Mae and Freddie Mac since the government set up the mortgage entities. In the decades since, Fannie and Freddie have been attempting to help Americans become homeowners by meddling in the credit markets to create cheaper home loans. And, as it turns out, that meddling may now be closer than ever to accomplishing it’s goal.

The Case-Shiller index, which tracks home prices in 20 major cities, showed a drop today of home prices back down to what should be looked at as historical norms. Many market watchers believe home prices may drop another 25 per cent before levelling out in 2010. Some believe they could drop even further. (Today’s Cash-Shiller news was mixed, with the narrower 10 city index of home prices showing a slow-down in price declines and the broader 20 city index showing further acceleration.)

The housing boom of the first six years of this century is largely responsible for this historic decline in prices. It drove prices up on existing homes and encouraged a home building glut. There are now so many unsold homes on the market that home prices will likely go below historically normal levels. In short, we’re getting close to a historically unprecedented level of home affordability.

Fannie and Freddie played an important role in achieving this. By securitizing mortgages, encouraging loose lending practices and pushing mortgage levels down, the mortgage giants created an illusion of enormous wealth available by investing in housing. Financial firms invested heavily in pursuit of that wealth, pouring money into the housing market. While this temporarily made housing extremely unaffordable, that process is now being undone.

Of course, this isn’t how it was supposed to work. Fannie and Freddie didn’t plan, as far as we know, to cripple the financial system and send the economy into a recession in order to achieve better housing affordability. And, in hindsight, historians may quesiton whether the benefits of affordable housing were worth the enormous costs. But that kind of societal cost benefit analysis was never part of the mission of Fannie and Freddie. They were supposed to help Americans achieve homeownership. Now that housing is getting even more affordable, it’s not really that much of a stretch to say they’ve done a hulluva job. Mission accomplished.

Of course, if conditions deteriorate further, and the incomes of Americans take an even bigger hit due to a worsening economy and labour market, houses could become even less affordable. If declining incomes outpace declining home prices, homeownership will return to unafforability.

But even this could ultimately make housing affordable. Declining incomes will drive up defaults, further cripple financial institutions and perhaps ultimately force the government to actually take over foreclosed properties. The government could become the landlord of last resort, and political pressure will surely encourage the government to sell houses to Americans at even further discounted prices.

That would throw off the projections that the government may actually make money on the bank capital it has purchases or the troubled assets it plans to purchase, which would mean that the government could have trouble paying back some of the debt that it has taken on to bailout out the banks and the economy. It won’t be able to tax its way out of the situation because incomes will be declining and the economy contracting. But it will be able to inflate its way out.

Of course, inflation itself will have a cost. Those mortgages will be paid back with depreciated dollars, meaning the real losses of the government and surviving financial institutions (we assume there will be some) will be even greater than expected. And future borrowing will become more costly.

But, you know, we’ll have lots of affordable housing. So that’s something right? Who says we’re always negative around here?